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Hi, can you please help me answering this M.C.Q (with its calculation).
TR Co has a gearing level of 1:3 debt:equity, TR is considering diversifying into a new market. B Co is already operating in the new market. B Co has an equity beta of 1.05 and a gearing level of 1:4 debt:equity.
Both companies pay 30% corporation tax.
The risk free rate is 4% and the market premium is 4%.
What is the specific project cost of equity?
A. 4%
B. 7.6%
C. 8.4%
D. 6.3%I will answer, but this forum is not a place to simply expect answers to test questions.
You must have an answer in the same book in which you found the question and you should ask about whatever in the answer is causing you a problem.You need to ungear the equity beta of B, which gives an asset beta of:
(4 / (4 + 0.7)) x 1.05 = 0.8936Then you need to regear this asset beta using TR’s gearing, which gives an equity beta of:
0.8936 x ((3 + 0.7) / 3) = 1.102Then you apply the basic CAPM formula to get a cost of equity of 4% + (1.102 x 4%) = 8.4%
All of the above is explained in detail in my free lectures.
Dear Mr John,
Thank you very much.
I just get confused with the regearing where i put the E/(E+D(1-T) instead of E+D(1-T)/E.
I hope it will goes well for tomorrow 🙂
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